How to Find Value in Real Estate With ‘Risk On, Risk Off’ Off Again
Recent trends, including falling stock correlations, have been strong indicators that the global economy is normalizing and the practice of “risk on, risk off” investing – in which investors enter and exit perceived riskier investments based on how they feel about the economy — is now off again after becoming a phenomenon in the post-financial crisis years.
What this means is that we may be entering into a period in which the individual circumstances of a company, such as its earnings or fundamentals, are more important factors than large macro events, such as the eurozone crisis or the US debt ceiling, in the success of an investment.
One clear sign of this shift has been the collapse of correlations between stocks in the US equity market. For example, stocks in the Russell 1000 Index had a weighted average correlation of 0.30 to the index itself as of July 31, the lowest month-end level since 2007 and down from 0.57 a year earlier, according to Deutsche Bank data, The Wall Street Journal reports.1 To put such numbers in context, the scale for measuring correlation goes from -1 (perfect negative correlation) to 0 (completely uncorrelated) to 1 (perfect positive correlation).
Rising stock prices put even greater pressure on investors and investment managers to find value in today’s market.
As fundamental real estate managers, we believe stock selection — rather than country, REIT sector and/or currency weights — offers the best opportunity to add value. As a result, we don’t over emphasize such macro issues as government or central bank policy.
Over the long term, we believe our bias toward lower-leveraged, better-quality companies essentially eliminates from consideration those companies with a lower outlook for their markets, lower quality of management and assets, weak corporate governance and higher financial leverage.
While these lower-quality stocks have benefited from risk on, risk off environments, we believe the types of higher-quality stocks that we favor will be rewarded with better valuations over time, and we believe our strategies are poised to outperform in a more normalized environment. Overall, we feel positive about the longer-term prospects for returns and our strategies.
In this new, developing era that favors stock-picking, we believe quality-oriented strategies are the best solution to overcoming the challenges of finding real value in today’s market.
1 Source: The Wall Street Journal, “Stock Break From Herd,” August 18, 2013
The Russell 1000® Index is an unmanaged index considered representative of large-cap stocks. The Russell 1000 Index is a trademark/service mark of the Frank Russell Co. Russell® is a trademark of the Frank Russell Co. An investment cannot be made directly in an index.
Investments in real estate related instruments may be affected by economic, legal or environmental factors that affect property values, rents or occupancies of real estate. Real estate companies, including REITs or similar structures, tend to be small- and mid-cap companies and their shares may be more volatile and less liquid. The risks of investing in securities of foreign issuers can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.